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For Teachers, Object Lessons From the 401(k)

FLIPPING through her husband's retirement-plan paperwork two years ago, Julie Vore thought it invited a simple question. ''I'm a big fan of no-load funds,'' she remembers thinking. ''Why can't we have that?''

Ms. Vore, 30, a tax lawyer in Columbus, Ohio, whose husband teaches industrial technology at a suburban high school, just wants the sort of choices that many Americans take for granted in their 401(k) plans. But her husband's options are limited mostly to annuities with high fees and funds that carry hefty sales charges -- either of which can only erode the couple's return on their retirement savings.

So she has taken matters into her own hands. She collected 15 account applications from school employees -- the total required before she could ask the Westerville, Ohio, schools to add low-cost funds from the Vanguard Group to its plan. Now there is one more hurdle: The school district will ask Vanguard to sign a contract taking responsibility for any mistakes in handling the teachers' accounts, a requirement at which Vanguard has often balked in the past.

''It's a real irritation,'' Ms. Vore said. ''If I didn't have 30 more years of investing in front of me, I probably would not have waged this battle.''

Ms. Vore is hardly alone in doing her homework. As more teachers learn more about investing, many have become fed up with their tax-deferred retirement plans, known as 403(b)'s, after the tax-code section that created them.

The 403(b)'s, which allowed teachers to shelter retirement income from taxes long before the establishment of 401(k)'s gave the same advantage to other workers, have now fallen behind through neglect and inertia. And that has prompted some teachers and their families to become activists, challenging school boards to cut plan costs and to find better places for teachers to put their money.

''This is a no-brainer,'' said Luke Collins, a managing director of KPMG's investment consulting group, which helped the Chicago public school system overhaul its 403(b) plan last year. ''If you've got a retirement system that offers 403(b)'s and it was set up more than five years ago, chances are you're paying too much in fees.''

Many teachers, of course, can count on generous state pensions to help them through retirement. And many others are happy with their choices.

But a great many aren't. Besides incurring high costs in their plans, teachers must often sort through a bewildering array of investments with little objective help from their employers, financial publications or advice on World Wide Web sites. Instead, they are pitched by sales agents in the teachers' lounge or cafeteria, much as they were a generation ago.

Ignorance has its costs: Even many teachers who invest consistently have missed out on the big returns of this decade's bull market. While more than two-thirds of 401(k) money is invested in stocks or stock funds, half of 403(b) money is sitting in fixed annuities, according to Spectrem Group/Access Research, a financial consulting and research firm based in San Francisco. Such investments often return little more than bank certificates of deposit.

BUT most teachers have sat out the game entirely. Only about two in five public school teachers even have 403(b) accounts, according to Spectrem -- in part because only 9 percent of school systems offer matching contributions, as most companies with 401(k) plans do. A result is that teachers are passing up a chance to shelter up to $10,000 a year in retirement savings from taxes.

As teachers and their advocates, like Ms. Vore, are learning, it doesn't have to be this way. Their efforts are beginning to force changes in this sleepy but lucrative segment of the financial services industry. Some bigger school districts are using their weight to improve their plans, while some insurance companies and other providers of investment vehicles are lowering fees or broadening investment options.

And 403(b) investors are taking advantage of the changes, redeploying their money into stock mutual funds or so-called variable annuities that have stock funds as their underlying assets.

The 403(b) market has long been dominated by the insurance companies, ''but what we're seeing is that it's opening up,'' said John Barth, a principal in the individual retirement services group at Vanguard, the nation's second-largest mutual fund company, after Fidelity Investments. ''Teachers are becoming familiar with the options because of all of the press, and people reading about mutual funds, and they are asking their schools to make them available.''

Some two million public school teachers have about $116 billion in 403(b) plans, according to Spectrem. (Employees of colleges, universities, private schools, charitable organizations and nonprofit hospitals have $350 billion in 403(b) plans, too. But by and large, benefits consultants say, they tend to have better plans.)

Annuities, the most common 403(b) investment for public school teachers, come wrapped with a layer of insurance and extra fees -- including so-called surrender charges that often take away up to 7 percent of a holder's investment if the annuity is sold soon after purchase. ''Fixed'' annuities promise investors a specified payout in the future; the returns of ''variable'' annuities depend on the performance of their underlying assets, usually mutual funds.

The insurance component, which by itself typically costs 1.25 percent of assets annually, usually offers this guarantee: If, at the time of the owner's death, the account is worth less than the contributions into it, the insurer will make up the difference. Some also guarantee a minimum amount of investment growth.

Fees, though, take a significant bite out of many annuities' value. The average annuity charges 2.11 percent of assets a year, according to Morningstar Inc., the Chicago financial researcher, while the average mutual fund charges about 1.36 percent. Many big funds that are popular in 401(k) plans are much cheaper; the Vanguard 500 Index fund is among the cheapest, charging 0.18 percent of assets annually, according to Morningstar. Many other popular 401(k) funds charge between 0.3 percent and 0.7 percent of assets a year.

Teachers who are lucky enough to have had 403(b) funds invested in equities during this decade -- even through higher-cost variable annuities or mutual funds with heavy sales charges -- can be forgiven for not noticing the fees they have been paying. During the bull market, most stock-based investments have risen so much that the effect of high fees hasn't been obvious.

''The big villain here, ironically, is the bull market,'' said Mr. Collins, the KPMG consultant. ''When the market is up 20 or 30 percent a year, average investors just don't pay attention to fees.''

But even a small difference in fees can add up to a huge amount over a career, because of the power of compound interest.

Here is an example from Steve Butler, an employee benefits consultant at the Pension Dynamics Corporation in Lafayette, Calif.: A couple contributes $10,000 a year into a retirement plan through equal payments twice a month. If their investment earns 10 percent a year, after fees, they will have $641,000 after two decades and $1.9 million after three decades. But if their investments earn just 9 percent, because the annual fees are 1 percent higher, they will have $75,000 less after 20 years, and $355,000 less after 30.

Ted Leber, a retired Navy captain whose son and daughter-in-law are public schoolteachers in Maryland, worries that they will lose more than $100,000 in retirement savings over their careers because they can't get no-load funds for their 403(b) accounts. He has called their school benefits office and asked whether the district could add low-cost funds.

''It tugs at my heart knowing my kids are going to lose 25 percent or 30 percent of their nest egg because of these damn fees,'' he said.

It's not as if there were no competition for teachers' retirement savings. Scores of insurance companies compete with one another to sell annuities to teachers, and the only requirement for participation in many systems is that the company sign some documents. Many school districts make no effort to filter out companies offering poor investments; in fact, some states forbid school districts from putting up barriers.

''They pretty much just kick the door open to anybody who wants to be on the list,'' said Richard Kouri, a former president of the Texas State Teachers Association who tried to alert teachers to the pitfalls of some 403(b) plans. ''In most places, there isn't a real screening process going on.''

Insurance sales representatives ''were pretty much the only people you would hear from,'' said Melissa Pickeral, who used to teach in two school districts in the Dallas area.

''The very first time I was approached, I was in my classroom during my break,'' she said. At her next school, a fellow teacher called her at home and pitched an annuity. ''I still get phone calls,'' she said, even though she is no longer teaching.

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That traditional marketing structure puts a greater emphasis on the teacher's relationship with a sales agent than on an investment's costs or features, according to a study by Cerulli Associates, a employee benefits consulting firm in Boston. Insurance companies, it said, pay sales representatives more for selling retirement products than mutual fund distributors do.

To be sure, many teachers give high marks to annuities and to the people who sell them. Some teachers even acknowledge needing a degree of hand-holding that no-load fund companies -- and even some brokers who sell load funds (those with sales charges) -- cannot provide.

Insurers say the shift by teachers to equities makes an agent's advice more valuable. ''The market used to be primarily fixed products, but now you're seeing people really looking for more variable investments,'' said Barbara Hume, a vice president in the retirement and savings center of the Metropolitan Life Insurance Company, one of the biggest providers of investments for public-school 403(b) plans. ''They're looking for a lot of advice and expertise.''

Insurance companies also offer advice to investors on topics like estate planning that fund companies often won't, she added.

And as Ms. Vore has found so far in Ohio, annuity companies and brokers who sell load funds are often the only providers of 403(b) investments willing to indemnify school systems from legal liability if problems arise from improper payroll deductions or other reasons. Liability has been a growing concern in recent years as the Internal Revenue Service has increased audits of school districts to insure that employees are not sheltering too much pay.

STEPHEN SCHULLO, an elementary school teacher in the Los Angeles Unified School District, has tried to have Vanguard added to the district's list of investment options. Now, he said, employees can buy mutual funds from Vanguard only by going through a state agency and paying $34 a transaction -- a ludicrously high fee, Mr. Schullo says, for teachers contributing a few hundred dollars a month.

Vanguard would like to become part of the district's plan, but the fund company won't sign the ''hold harmless'' indemnity agreement that the schools want. ''I've come up against a very tall and solid brick wall,'' said Mr. Schullo, who gave a presentation on the problems with 403(b) plans last month at an investment conference sponsored by The Los Angeles Times.

Most district employees are satisfied with the choices they have now, said Karen Hemingway, the district's director of contract and insurance services. The district wants the hold-harmless agreement, she added, because ''we don't want to take on a liability that we don't need to.''

In Westerville, the district where Ms. Vore's husband teaches, Carl Claphan, the treasurer, noted that Ohio law prescribes the process for adding a new investment company -- including the requests from teachers and the indemnification agreement. Officials, he added, have to balance the interests of teachers with those of taxpayers, and he worries that adding Vanguard could increase administrative work for the school system.

''People want us to use tax dollars efficiently, so we try to do that,'' he said.

Though not sure what fees are now paid by teachers through their 403(b) investments or whether it was even possible to have no-load funds offered in the plan, he said that ''most companies, as far as I know, do not have exorbitant fees.''

Public school systems are not the only employers to deal with these issues.

In Malta, Mont., a town of 2,300, the Phillips County Medical Center revamped its 403(b) plans two years ago, and about 80 percent of eligible employees now participate, according to the hospital administrator, Larry Putnam. Previously, the hospital had some load funds in its plan, but it now has no-load funds from Vanguard, the Janus Capital Corporation and others. The hospital also holds regular meetings to give employees information about their options.

Mr. Putnam said he never considered offering annuities in the revamped plan. ''Fees are important in any kind of investment,'' he said.

Indeed, some school districts, too, are finding that they can come up with plans that protect them legally while giving teachers good investment choices.

In the Blue Valley School District in Overland Park, Kan., 30 companies were selling products to more than 2,000 district employees until two years ago, when concerns about compliance with tax rules prodded officials to narrow the choices to four companies, said Alan Hanna, the assistant superintendent for human resources.

''It was very confusing,'' he said. ''We would provide employees a list of companies and phone numbers. They knew they needed to be investing but were bewildered with what they needed to do.''

The new program includes two standard annuity companies, since some teachers still want to ''sit across the kitchen table'' from a sales agent and are willing to pay for the service, Mr. Hanna explained. But it also offers investments from American Century, the no-load fund company based in nearby Kansas City, Mo., and TIAA-CREF, the giant college and university pension system and financial services concern.

While TIAA-CREF sells annuities, they carry lower expenses than most mutual funds, have generally strong investment track records and are well regarded by investment advisers. But serving Blue Valley is an exception for TIAA-CREF because public school systems historically have been too decentralized and complex to work with, said David Shunk, the company's executive vice president in charge of retirement services. (TIAA-CREF, based in New York, dominates the 403(b) market for colleges and universities, holding employee assets of more than $250 billion.)

IN Chicago, a revamping of the schools' 403(b) plan is expected to save employees more than $6 million annually in fees, according to officials. Previously, teachers paid 2 to 3 percent, on average, in annual fees on their investments, and more than two-thirds of their assets were tied up in fixed annuities, officials said.

Now Chicago teachers can buy no-load funds through Prudential Retirement Services, a unit of Prudential Insurance, or annuities through the Variable Annuity Life Insurance Company, a subsidiary of the American General Corporation in Houston that is the country's largest seller of annuities in public schools. Valic has reduced fees and eliminated surrender charges on many of its annuities. The Valic plan also allows teachers to buy mutual funds through Charles Schwab & Company.

If fed-up teachers alone cannot forge changes in 403(b)'s, they may have some help from class-action lawyers.

Milberg Weiss Bershad Hynes & Lerach, a law firm that specializes in shareholder suits, is seeking class-action status for lawsuits filed against four groups of companies that sell annuities for retirement plans, including 403(b) plans.

The suits say a big selling point of annuities -- tax deferral on investment gains -- is redundant in a 403(b) because, like a 401(k), it is funded with pretax earnings that grow tax-free until withdrawal.

''They sell them as 401(k)-type investments without explaining that they are getting a redundant benefit,'' said Melvyn I. Weiss, a senior partner in the firm. ''These annuities have become very popular, and the practice of marketing them for retirement plans is highly abusive.''

The companies all declined to comment or said the lawsuits were without merit.

Finding New Homes for Savings in a 403(b)

Want to transfer money in a 403(b) retirement plan to an investment company not on your employer's approved list? You may be able to do it -- but it could be expensive.

If your employer contributes to your plan, or if it is an employer-sponsored program or covered by the Federal Employee Retirement Income Security Act, or Erisa, there's a good chance you won't be able to make transfers. Some employers also have agreements with the investment companies in their plans not to allow them.

To make a transfer, call the mutual-fund or insurance company you want, and, if it accepts such requests, it will send you a form to fill out. But only money already in an account can be transferred; continuing contributions to your 403(b) must still be made to the annuities or mutual funds approved by your employer. That means you still must pay any fund sales charges or annuity surrender charges, which typically strip away up to 7 percent of principal.